Europe Austerity Push Deepens After Rescue Message

By Emma Ross-Thomas -
May 12, 2010

Spain and Portugal may be getting the
message as they try to stop their economies from becoming
infected by the Greek crisis.

Two days after other European governments told them to fix
their budgets in return for a $1 trillion backstop, Spanish
Prime Minister Jose Luis Rodriguez Zapatero yesterday announced
the biggest round of budget reductions in 30 years. In Portugal,
Finance Minister Fernando Teixeira dos Santos says he’s prepared
for “social tension” after announcing additional cuts.

Policy makers are running the risk of union opposition as
they force through austerity measures to convince investors they
won’t join Greece in asking for an international bailout. While
some economists said the European Union lifeline could take
pressure off deficit-laden nations to act, it was enough to
prompt Zapatero to announce a 5 percent cut in public wages.

“The fiscal announcements serve to suggest that the
momentum now is indeed towards fiscal cuts,” said Erik Nielsen,
chief European economist at Goldman Sachs Group Inc. in London.
“What we have in the euro zone policy space right now is ‘moral
suasion,’ not ‘‘moral hazard.’’’

The yield on Spain’s two-year government bond dropped 12
basis points to 1.861 percent yesterday after rising to a euro-
era high of 3.143 percent last week. Portugal saw more demand at
a sale of 1 billion euros ($1.3 billion) of 10-year bonds
yesterday, with the debt priced to yield 4.52 percent, down 181
basis points from the May 7 high.

The planned deficit reduction, to 6 percent of gross
domestic product in 2011 from 11.2 percent last year, would be
the largest two-year cut since at least 1980.

“This is a turning point,” said Fernando Fernandez, a
professor at the IE business school in Madrid and a former
International Monetary Fund economist. “The prime minister has
had a fright and come down to earth at last to understand the
reality and what’s at stake here.”

The euro headed for its first advance in three days, rising
0.2 percent to $1.2643 as of 9:19 a.m. in Tokyo. The currency
reached a 14-month low of $1.2529 on May 6.

U-Turn

Zapatero’s plan, which marks a policy U-turn for the
Socialist premier, came as the European Commission outlined new
proposals for governments to “decisively” toughen budget rules
and impose swifter penalties on nations that break them.

The 27 EU members should reinforce fiscal surveillance,
improve compliance with the bloc’s budget rules and focus more
on cutting public debt, the Brussels-based commission said
yesterday. Governments are required to keep their deficit below
3 percent of GDP.

Those repeatedly breaching the rules should face “more
expeditious treatment,” it said.

EU Economic and Monetary Affairs Commissioner Olli Rehn
said the Spanish cuts “seem to go in the right direction,” as
the nation renewed a pledge to meet the deficit limit in 2013.
The steps include a 6 billion-euro reduction in public
investment, a pension freeze and the end of a 2,500-euro subsidy
for new parents.

Dos Santos said that further steps to cut spending and
raise revenue are planned.

Spain and Portugal are bracing for opposition from unions
one week after Greek demonstrators torched buildings in Athens,
leading to three deaths.

New Relationship

The approach marks a change for Zapatero, who told workers
in 2005 he slept with his union card by his bed and who has
tended to consult workers’ representatives before announcing
policy shifts. Spain’s last general strike was in 2002, when the
People’s Party was in power.

The move “marks a change in relations” between workers
and the administration and protests will follow, said Candido Mendez, secretary general of UGT, the country’s second-biggest
union.

In Ireland, 70 protesters tried to storm the country’s
parliament yesterday after they broke away from a march against
the government’s plans to bail out the country’s banks.

Still, demonstrations have failed to budge government
policy in Greece, and Spain has managed to reorder its finances
in the past.

“Spain has a very good track record of implementing
austerity measures,” said Jose Garcia-Zarate, a fixed-income
strategist at 4Cast Ltd. in London. “I don’t think the Spanish
government suffers from the same degree of lack of credibility
as Greece.”

Teixeira dos Santos, who cut Portugal’s deficit in half in
the two years after taking office in 2005, says union opposition
wouldn’t be an obstacle to his country’s budget plans.

“We have to take measures to cut expenditure and increase
revenue” said Teixeira dos Santos. “We’ll face the social
tension.”